18.

18 Election for Special Treatment of Profits from Patents (Patent Box)

For profits made from 1 April 2013, a company may elect that any relevant intellectual property (IP)
profits related to a trade of the company, for an accounting period for which it is a qualifying
company, are effectively chargeable at a lower rate of corporation tax. CTA 2010, s.357A

A qualifying company is one which at any time in the accounting period:

• holds any qualifying IP rights, or

• holds an exclusive licence in respect of any qualifying IP rights. CTA 2010, s.357B

The qualifying IP that is covered by these rules includes:

• A patent granted in the UK or Europe,

• A right similar to the above, granted under the law of a specified EEA state,

• A supplementary protection certificate, and

• Plant variety rights. CTA 2010, s.357BB

The relief was phased in over 5 years. For FY 2017 onwards, the effective rate of corporation tax is
10%.

The aim is to provide an additional incentive for companies to retain and commercialise existing
patents, and to develop new innovative-patented products.

This will potentially benefit a wide range of companies, which receive patent royalties, sell patented
products, or use patented processes as part of their business. It applies to both existing and new IP,
and acquired IP if the company has further developed the IP. CTA 2010, s.357BC

PATENT BOX DEDUCTION:

Relevant IP Profits x (Main Rate of CT – IP Rate of CT)

Main Rate of CT

In broad outline, the following procedure is taken to calculate a company’s relevant intellectual
property profits (RIPP): CTA 2010, s.357C

Step 1: Percentage (X%) of Relevant IP Income (RIPI)

• Ascertain TI (Total Gross Income)

• Calculate RIPI/TI x 100% and Call this X% of RIPI

In our case, the total gross income generated is from IP. Hence, this is 100% for our calculation.

Step 2: Relevant Trading Profits (RTP)

• Percentage of adjusted trading profit relates to patented items

• 100%
Step 3: Deduct from RTP (two notional amounts)

• Routine Return on costs (RR), and

• Notional marketing return (MAR)

The resulting figure is the amount of the company’s relevant IP profits (RIPP) and they are subject to
the “patent box rate” of corporation tax as described above.
Routine Return on costs (RR)

‘Routine deductions’ means expenditure falling within any of the six heads below provided that they
are not subsequently determined as not routine deductions.

Routine Deductions Categories:

• Capital allowances (any WDA on fixed assets)

• Premises costs (rent, rates, repair and maintenance)

• Personnel costs (in respect of directors or employees)

• Plant and machinery costs (costs of leasing, constructing, modifying, maintaining, servicing,
operating, etc)

• Professional services (This includes legal services (but not IP-related legal services), financial
services including accounting, audit, actuarial and valuation functions and costs associated with the
administration and management of the company)

• Miscellaneous services (This includes computer software and other computing costs; supply of
water, fuel and power; telecommunications services; postal services; transportation of any items;
waste disposal services)

• Exceptional items (Routine expenses may include exceptional items that significantly affect the
amount of profit that qualifies for the beneficial CT rate)

Not routine deductions – Categories

• Loan relationship etc debits (Debits in respect of loan relationships or derivative contracts are not
routine deductions)

• R&D expenses (R&D expenses are excluded from the calculation. This recognises that these
expenses are likely to have a direct correlation to the creation and development of qualifying IP.)

• RDA and patent allowances (Research and development allowances and patent allowances)

• R&D employee share acquisitions (Deductions relating to relief given for employee share
acquisitions under CTA09/Part 12 are allowable to the extent that the employee is engaged in
relevant R&D activities.)
Notional marketing return (MAR)

If a company does not elect for small claims treatment, there are provisions to exclude the profit
from marketing assets to arrive at the relevant IP profits. This is to focus the benefit of the Patent
Box on technologies covered by relevant IP rights and should exclude the profit attributable to
marketing assets.

To calculate the profit attributable to such assets, known as the ‘marketing assets return figure’, the
legislation uses the formula:

NMR - AMR

where,

NMR is the notional marketing royalty (CIRD220500),

AMR is the actual marketing royalty (CIRD220530)

The marketing assets return figure is nil if:

 AMR is greater than NMR, or

 The difference between NMR and AMR is less than 10% of QRP for the accounting period.
Notional Marketing Royalty

The notional marketing royalty (‘NMR’) is the percentage of relevant IP income which the company
would pay a third party for the exclusive right to exploit the relevant marketing assets if the company
were not otherwise able to exploit them.

Example:

Company B develops an innovative concept and patents it. It decides to manufacture and sell
products using the patent itself and registers a trademark to do so.

Company B’s NMR will be based on the appropriate arm’s length royalty it would pay for the
marketing assets, within the meaning of the definition given in S357CL, that it possesses. These will
include its trademark.

For the accounting period of the year in which the product is first sold the ‘appropriate percentage’
will be minimal, assuming no marketing activities have yet been carried on, and hence the marketing
assets will have little if any value. Assuming the product is successful, the NMR in later periods will
be similarly determined by applying the arm’s length principle and may be quite significant
depending upon the relative impact upon sales of the marketing assets as compared to the other
functions and assets of the company including the patent.

At the beginning of Year 4 it is reasonably anticipated that the turnover and profits of Company B
from sales of the patented product for the remaining period of the licence will be £100m and £30m
respectively.

An analysis undertaken in accordance with the OECD Transfer Pricing Guidelines results in the
application of a profit split methodology which concludes that the profit is attributable 60% to the
patent and 40% to the goodwill established solely due to the marketing efforts of Company and
signified by the trade mark.

Consequently, the appropriate arm’s length royalty rate to be used in calculating NMR for the
accounting period will be 12% i.e. ([40% x £30m]/£100m) x 100.

If actual sales and profits of Company B in Year 4 are £10m and £3m respectively, NMR will be £1.2m
(i.e. £10m x 12%) leaving £1.8m as relevant IP profits (subject to any routine return already
deducted) falling within the Patent Box. In practice, the relative contributions of the marketing
assets and the patent may not vary significantly once the product has become well-established.
Actual Marketing Royalty

The actual marketing royalty is the part of the return to marketing assets which accrues to third
parties. It is defined as a proportion of the aggregate amounts paid in order to use the relevant
marketing assets and brought into account as debits in the corporation tax computation for the
accounting period. This amount could be a royalty paid to use a marketing asset or an amortisation
charge in relation to an acquired marketing asset.

Small claims treatment:

In order to elect for small claims treatment a company must meet either condition A or condition B.
Condition A
The QRP of the company does not exceed £1,000,000.
Condition B
 The QRP of the company does not exceed the relevant maximum; and

 In the previous four years the company has not calculated its Patent Box profits by following Step
6 in section 357C.

 The relevant maximum is: 3,000,000 / (1+N)

N = number of 51% group companies for which a Patent Box election has effect for the relevant
accounting period.

The legislation provides two possible methods for determining how much of the QRP of a company
for an accounting period represents profit from qualifying IP rights and how much relates to brand
and marketing assets.

The simpler of these two methods is the small claims treatment and provided that the company is
eligible, it allows the company to elect to adopt a formulaic approach.

If the company is eligible to elect for small claims treatment then S357CM stipulates the relevant IP
profits for the accounting period to be the lower of two amounts:

 75% the sum of the QRP of all the company’s trades; or

 the small claims threshold (£1 million).